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This question was answered comprehensively and succinctly by Matthew Chan, entrepreneur, designer, cryptocurrency enthusiast, and creator of MatrixPortfolio.com, a mobile app for crypto investors.

The original article was published on Hacker Noon, translation on our portal https://pro-blockchain.com.

I want to convince you why blockchain is necessary, why we need to motivate people to pursue decentralization and its benefits, and why tokens are needed and what underlies their value. Now that the cryptocurrency market is increasingly saturated, it is important for us to understand the underlying technologies and principles behind digital money, as this understanding will allow us to make smart investments and separate the important from the non-essential.

In fact, blockchain borrows a lot from game theory and motivational models. For a blockchain network to be valuable and/or useful, it must have participants. It will be useless if only you and I are blockchain users.

In order to attract participants, some form of motivation is required. The most common means of motivation is a reward in the form of a token. The more participants there are, the more decentralized the network becomes.

Why not just a database? Why do projects need blockchain?

A decentralized system has several advantages over a centralized server / database:

● immutability;

● security;

● backup;

● cost reduction;

● accountability and transparency.

Immutability

When data and records are decentralized and hosted on a blockchain, they are virtually impossible to falsify or change. If you store data on, say, a personal computer, you can easily alter a file before sending it to another person. How can you be trusted in this case?

Security

Traditional servers or data tend to be centralized, making them an attractive target for attacks. The Equifax security breaches and other recent cybersecurity issues are a case in point. A single server or a limited number of servers can easily fall victim to hackers, but decentralization through blockchain puts a serious damper on attackers. The more participants and nodes in the network, the more copies of data exist. Therefore, in order to modify data, it is necessary to attack every single node in the network and modify all the data at the same time. Blockchain not only serves as a defense against theft, but it has virtually no vulnerabilities. Each block on the chain contains a certain amount of data, and when that block gets full, like a USB flash drive, the data is encrypted and sealed forever. To get the whole picture, hackers would need to hack not only the current block, but every block preceding it. Not only is this nearly impossible technically, but it is also expensive. Thus, the incentive for criminal activity is reduced. I am now describing the concept in general: different blockchains use different security measures and algorithms.

Backup

If the dataset is distributed globally, you don’t have to worry about losing a single copy. Thanks to this, you can protect against corporations getting rid of data tampering, server failures, etc.

Cost reduction

A decentralized network of nodes supporting a registry helps companies reduce hosting, security and maintenance costs. In addition, decentralization saves on salaries for IT professionals, developers, and infrastructure managers. For example, Apple’s servers are literally under constant attack, forcing teams to monitor them 24 hours a day, 365 days a year.

Accountability and transparency

With the above in mind, you can rest assured that all information recorded on the blockchain is authentic. This allows one to do business in a transparent manner, freeing one from having to trust the opposite party. One can always turn to the blockchain, letting the data and facts speak for themselves.

Are today’s data infrastructures workable? Undoubtedly, but they are far from perfect. They worked as well as they could because there was no blockchain, a technology that enables significant improvements.

Okay, but what gives tokens value? Why are they in demand?

It depends on the project. 90% of all projects are worthless, but we’re going to talk about tokens that have real value and are actually applicable.

As I mentioned earlier, tokens are often used as a means of motivating network participants: a successful network implies many participants contributing to its decentralization and protection. The more participants there are, the more the network benefits. This is precisely the case of bitcoin. When Satoshi introduced it to the world, bitcoin had zero value. At that time, the only participant in the network was Satoshi himself. But now, as bitcoin becomes more widespread, people increasingly agree that the bitcoin token is useful as a currency and therefore has intrinsic value to the participants in the network.

In general, there are several classes of tokens, and each class has its own specific value.

Currency tokens: Bitcoin, Monero, Raiblocks, etc.

Utility tokens (utility tokens), which allow to perform some activity in the network, examples are ETH and ZRX. In the etherium network, ether is used for smart contracts.

Asset tokens, representing an actual asset or product.

Equity tokens (equity tokens), which function as securities. They give the right to vote and participate in decision-making.

The value of currency tokens, such as bitcoin, is determined primarily by their ability to function as currency and a store of value.

The value of service tokens is determined by the popularity and usefulness of the network: for example, the amount of data that is hosted on the blockchain and the amount of information that is processed, as there are parties willing to pay fees for processing, validation, transmission and protection of data. These could be decentralized exchanges or companies hosting supply chain data on the blockchain, etc.

Asset tokens can be linked to the value of the real assets they represent.

Asset tokens can be valued based on investor sentiment and the progress of the project itself. What plays a role here is whether they are used in commerce and accepted by the real world, what voting rights their holders have, the potential and direction of the company, etc.

So what influences the price of tokens?

Now that we know what the source of value of tokens is, it’s time to ask this question.

Different projects and tokens may have different incentives or economic models that affect the price. Speculation aside, there are certain technical factors that affect the price regardless of investor sentiment.

Demand and consumption. This is likely the most significant factor in the question of token value, especially these days when the market is purely speculative in nature.

Popularity/utility. This factor has to do with answering the questions of whether there is any activity on the network and how widespread the token is.

Burn rate. Do tokens lose value over time? At what rate?

Circulation and reserves. How many tokens are in circulation? Is there an «untouchable reserve»?

Generation of secondary tokens (such as NEO/GAS, etc.).

Mining/premining. How many coins have already been released and what is the release schedule? Or have they all been mined already?